When you’re starting a business, you will need to decide if you want to form a separate “legal entity.” In some cases, you may choose not to have a separate business—if that’s the case, you’ll be treated as a “Sole Proprietor” or a “Partnership.”
If you do choose to create a separate legal entity, you have a few choices:
- Limited Liability Company (LLC)
- S Corporation
- C Corporation
- Nonprofit Organization
For most business owners, the LLC is a good choice. It combines a fairly light administrative overhead with “liability protection” that separates your personal assets from your business assets. In some cases though, you will want to form an S Corporation or a C Corporation, and it’s important to understand the differences between them. Here are the answers to many of the common questions about corporations.
Starting an S Corporation or C Corporation
How Do I Create an S Corporation or C Corporation
You create both types of corporations by filing paperwork with your state’s business formation body, often the Secretary of State. The form you need to fill in is typically called “Articles of Incorporation,” “Certificate of Formation,” or similar.
Will I Have to Pay an Initial or Ongoing Fee to Have an S or C Corporation?
Yes. Both types of corporations will require an initial fee to create them, and in most states you will also need to pay an annual fee when you file a yearly report. Fees and filing requirements vary from state to state.
Can S Corporations or C Corporations Limit My Personal Liability?
Yes. Because corporations are considered to be separate legal entities, your personal assets, like your bank account, home, or car, are not typically at risk if your business has problems like bankruptcy or legal troubles.
C Corporations offer the strongest type of liability protection. S Corporations do as well, but they may not be as strong as for a C Corp.
S Corporation and C Corporation Ownership
What Are the Differences in How S Corporations and C Corporations are Owned?
Both types of business are owned by investors that have purchased stock in the business. The difference is that S Corporation shares are owned by private investors—those invited to invest by the S Corporation founders. C Corporation shares can be publicly owned, so they can be bought, sold, and traded on open stock markets.
This means any business that is taken public on a stock market, usually through an Initial Public Offering (IPO) must be a C Corporation.
How is the Management Structure of an S Corporation or C Corporation Decided?
In both cases, the management structure and board are elected by the shareholders.
Are There Differences in How S Corporations and C Corporations Can Raise Capital?
Yes. Both types of corporations can raise money through loans and financing. They differ in how they raise money by selling stock. S Corporations raise money by selling private stock to investors, while C Corporations sell public stock.
Are There Differences in the Compliance, Regulations, and Overheads of Corporations?
Yes. Both types of corporations must meet certain minimum standards and regulations, such as holding an annual meeting, minuting board meetings, and electing the management structure. Additionally, C Corporations have several other strict requirements they must meet related to taxes, financial statements, and other areas. This means that S Corporations typically have a moderate amount of regulations, while C Corporations have a lot of regulations.
S Corporation and C Corporation Shareholders
Is There a Limit to the Number of Shareholders Each Type of Corporation Can Have?
For an S Corporation, yes. They can have a maximum of 100 shareholders. C Corporations don’t have any limits to how many shareholders they can have.
Are There Other Restrictions to Stock Ownership for S Corporations or C Corporations?
S Corporation shareholders are limited to being U.S. citizens or residents. C Corporation shareholders can be of any nationality. S Corporations only have one class of stock, whole C Corporations can have many.
S Corporation and C Corporation Taxes
Are S Corporations and C Corporations Treated Differently for Tax Purposes?
Yes, and this is where it can get complicated—let’s break it down.
S Corporations and Taxes
S Corporations pay taxes in several ways:
- S Corporations must pay a salary to employees and company owners. The salary will have payroll tax, federal income tax, state income tax, and a couple of other minor taxes applied to it.
- S Corporation owners can also choose to take some money out of the S Corporation as “distribution” income. This income will have federal income tax and state income tax applied to it.
- S Corporations report these taxes in various ways—through W2 and W3 forms, through an 1120S S Corporation Tax Return, and through the owner’s 1040 Federal Income Tax Return.
C Corporations and Taxes
C Corporations pay taxes in several ways:
- C Corporations must pay a salary to employees and company owners. The salary will have payroll tax, federal income tax, state income tax, and a couple of other minor taxes applied to it.
- C Corporations must also pay corporation tax on their profits.
- C Corporation shareholders may also be paid dividends by the company. These dividends will be reported as dividend income on the shareholder’s 1040 tax return and will be taxed there.
- C Corporations report these taxes in various ways—through W2 and W3 forms, through an 1120 C Corporation Tax Return, and through the owner’s 1040 Federal Income Tax Return.
Are There Any Tax Advantages to Either Type of Corporation?
Yes, in some cases an S Corporation can reduce the amount of tax that S Corporation owners need to pay. Here’s how to achieve this:
- The S Corporation pays its owners a “Reasonable Salary.” This salary is subject to all standard taxes, including payroll tax.
- S Corporation owners can also take money out of the business as a distribution. Money taken out of the business in this way is not subject to payroll or self-employment taxes.
- LLCs can also take advantage of this by electing to be treated as an LLC for tax purposes by the IRS.
C Corporations typically do not have a tax advantage. In fact, C Corporations are subject to “Double Taxation”—taxes they pay on company profits and then taxes that the shareholders pay on the dividends they receive.
We hope you’ve found this guide to the differences between S Corporations and C Corporations to be useful. In most cases, an LLC or S Corporation will be the right decision for your new business, but if you’ve got big ambitions, a C Corporation has a structure built for growth and stock ownership.